This Tweet by Bill Fleckenstein is worthy of comment because Mr. Fleckenstein is thoughtful and successful and he has earned our attention.
The sentiment he expresses here is obviously not new and not just his. Indeed, our Twitter feed is swamped by almost identical viewpoints from hundreds of others. Just try investing in Tesla since 2017 and you’ll know what we mean. We are sympathetic to Mr. Fleckenstein. We have been running long/short money since 2006. It has been a frustrating market in many ways for a decade. But it’s still a market. And as professionals, we have to identify the forces at play – like them or not – and react accordingly.
Baron Rothschild, who made a fortune in the 18th century going long France after the Battle of Waterloo, is famously credited with saying “The time to buy is when there’s blood in the streets. Even if it is your own.” We hear all the time how the “Fed” has destroyed price discovery and distorted markets. We have publicly disagreed with this for quite some time and explain why down below. But what if it IS the Fed? Are we going to lose client money “on principle?” We see the Fed doing – wait for it – what the Fed is supposed to do. Be the buyer of last resort, temporarily. If you don’t think the Fed programs worked as they should, you haven’t been paying attention to credit spreads. We’d be in trouble today without Fed programs. And, oh by the way, TARP was a pretty good outcome for Uncle Sam three or four years after.
As of June 3, 2020, there wasn’t as much blood in the stock market streets as in Q1 2020, but it’s still a good comparison. Think also of 1942, another generational low in US stocks. Getting beaten by Japan literally everywhere. As investors, we HAVE to play the cards we are dealt. The market’s reaction to the riots is hard to fathom. We get that. Until events of the last week begin to look like 1968, the market is signaling today’s riots as a major social event but a minor economic one; just like it has said The COVID is not likely to be the world-shattering lethal event as previously feared.
Climbing this clichéd “wall of worry” is hard to see through but is also something the market does regularly and has for decades. While federal programs like PPP and Fed programs like bond ETF purchases (which marked the bottom) have undoubtedly provided near term support this time around, such a massive response was predicted by many like @donluskin and should have surprised no one.
But one rarely hears of passives as a reason why markets have been so resilient and seemingly bulletproof. The market is now at 50% of all assets in passive strategies. That’s up from 20% pre-2008 and a massive shift with huge implications that must be taken into account by investors. Think of all the huge market capitalization companies now public that weren’t prior to 2008. Think of the flows of assets, every two weeks, finding their way into funds from payroll accounts, without fail, no matter what the backdrop, save someone losing a job. That force is what drives these V-shaped recoveries, not short-term Fed policies. That’s what has been driving correlations between stocks to rise, not the Fed. It is our job as professional money managers to identify the forces at play – the real forces – and react accordingly.
Thirty-five percent of the S&P 500 has had a negative 5-yr ave return. During a period of mostly benign interest rates and easy central bank policies. Why weren’t those 35% positively impacted by the Fed? You think big pools of passive flows want small caps? They can’t. They need liquidity. Go ahead and tilt at the Fed governors. You’d be smarter to tilt at John Bogle and Larry Fink. And act accordingly.